Is Herbalife a buy or a sell here?

Tom Lloyd worked in marketing for the specialist firm Adler Coleman, the
fundamental research firm Woolcott Research, the institutional broker Hoenig &
Co. and the registered investment adviser Koenig Advisers. Currently he markets
services such as StockpickerUSA.com to institutional
investors. He can be reached at
tomklloyd@verizon.net. Tom has an MBA in accounting. His articles have been
published in Technical Analysis of Stocks and Commodities Magazine and
SeekingAlpha.com. you can follow Tom on Twitter at
@tomlloyd12.

If you put on your quantitative fundamental blinders, Herbalife
HLF, -1.14%
looks great. The quant models I use at StockPickerUSA.com have it as a five-star buy. If you take the blinders off and look at the price chart and the business model, most portfolio managers will hesitate. Traders will play the latest breaking news from the company, the media, the hedge funds that are long and short, and the SEC. Who is right? Is this a long or a short?

The portfolio managers who owned HLF and sold after the first technical sell signal triggered — by questions about the HLF business model during an earnings call — are not about to return until the business-model questions are resolved. The business model determines whether or not HLF will be able to repeat the growth in earnings and sales.

If HLF is allowed to continue their business practices of the past, it is possible for them to repeat. The longs would be right. That would mean the price at its bottom was a great value, and the hedge fund that bought at the bottom has realized great gains. If the current price continues to move up, that could squeeze the shorts to pay higher prices as they panic and scramble to cover their short positions.

However, if the business model which currently records sales to distributors as actual sales is forced to change and record sales to final consumers who are not distributors but just customers, then sales may drop. There is nothing wrong with reporting sales to their distributors as sales for HLF. It just raises the question of how many of these distributors are stuck with inventory they cannot sell.

Those sales cannot obviously be repeated by HLF because the distributor may have a garage full of the unsold product. In which case, HLF has to find other distributors who are willing to fill the garage with product which they may not sell because they don't know how to sell or there is little product demand.

If the current media exposure convinces future distributors not to buy into HLF's distributor program, then obviously future sales will go down. If prospective distributors hear in the media about people who put down $10,000 and lost it, then it will be difficult for HLF to recruit new distributors.

If, indeed, it turns out that the only people making money are the ones who sign up new distributors and the only consumer is the distributor stuck with the inventory to consume, then the business model may have to change to something more like an Avon business model. That could reduce sales and profitabilty. In this case, the shorts would be right.

(Note: Nothing in this article recommends HLF as a buy or sell. Each person must do their own due diligence and consult with a professional financial adviser before acting on any information in this article. Trading on news announcements is very risky.)

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